Actively-managed funds that focus on the FTSE 250 typically find it difficult to add value, so trackers can be an attractive alternative, says Trustnet.

Its data shows the HSBC FTSE 250 Index fund has returned 54.07 per cent over a three-year period, compared with 57.77 per cent from the FTSE 250 itself.

Over five years, the difference between the index and tracker is around the same margin.

In the past decade, the tracker has returned 171 per cent, close to 30 per cent less than the index. But Trustnet points out only two of the six actively-managed alternatives with a long enough track record – Franklin UK Mid Cap and Old Mutual UK Select Mid Cap – managed to beat it during this period.

What about the Scottish Widows Foundation Growth - the cheapest tracker on the market?

Scottish Widows Investment Partnership launched a FTSE All-Share index tracker fund called SWIP Foundation Growth at around the start of the year - and it is billed as the 'cheapest' tracker on the market.

It is available at a cost of just 0.07 per cent a year in management fees. Add in other costs and it should theoretically cost just £1.10 per £1,000 invested. The percentage is bumped up slightly, because when you add the fund’s administrative costs, the total expense ratio (TER) works out at a still small 0.11 per cent.

However, there is a catch. The SWIP Foundation Growth fund is being offered exclusively to investors via the Hargreaves Lansdown Vantage fund platform in minimum investment sizes of £1,000 for lump sums, and £50 a month. [More details].

Total expense ratio

A total expense ratio or TER is a yardstick of how much a fund is really costing you. It includes the cost of management fees,
trading, legal, marketing, auditing and other operational expenses.

Hargreaves Lansdown changed the way it charges its investors on December 31 2011. It introduced a new flat-fee charge of up to £2 a month on certain tracker funds, scrapping its typical 0.5 per cent charge, capped at £45 a year.

The SWIP fund falls into this category. This means that anyone investing £1,000 in the tracker will have to pay a £2 monthly charge, or £24 a year.

That is 2.4 per cent per year and would mean an effective annual charge of 2.51 per cent - a horrendously high cost for a tracker and 23 times the quoted TER of the fund.

However, if you invest £10,000 and factor in that £2 monthly charge, the annual percentage it represents drops down to 0.24 per cent. This puts it back as the cheapest tracker you can buy, with an overall effective annual charge of 0.35 per cent.

Offsetting the monthly fee, an advantage of Hargreaves Lansdown's service is that fund purchases do not incur any dealing charges and it has annual Isa administration charge, both of which some rivals have.

The SWIP Foundation Growth tracker hasn't been running for long, but you can still get some idea of its tracker error. Over six months it has returned 2.41 per cent against the FTSE All Share's 2.33 per cent, while over three months it was down 0.52 per cent versus the All Share's 0.27 per cent gain.

How do Vanguard's trackers measure up?

Vanguard, the U.S. low-cost fund provider, offers a FTSE All-Share tracker fund with a low headline TER of 0.15 per cent.

But it imposed a ‘dilution levy’ on new investors, meaning it could only be bought without additional fund platform fees by investing £100,000 or more directly with the manager.

Vanguard says the levy is necessary to cover costs and the proceeds go back into the fund for the benefit of investors and not to the fund manager. If you do have a large lump sum over £100,000 and want to track the market with it, then it may be beneficial to invest in these funds, as the charges are so low.

If you have less than this, Vanguard funds are now also offered to UK investors via Hargreaves Lansdown’s Vantage fund platform, and BestInvest, Alliance Trust and Sippdeal platforms, as well as through financial advisers.

As well as the fund mentioned above, Vanguard has European and World index trackers with TERs of 0.25-0.30 per cent and a range of ‘Lifestrategy’ funds with TERs of 0.29-0.33 per cent. [More details]

The Vanguard funds also fall under Hargreaves' £2 flat-fee charge. This means that, as with the SWIP fund, buying these trackers works out much cheaper if you invest larger sums of money.

Vanguard funds are also available via Alliance Trust Savings. There is no monthly fee, but investors do incur a £25 annual charge and there is a one-off dealing fee of £12.50 on fund investments, or a regular online direct debit monthly investing fee of £1.50. [More details]

The Vanguard FTSE UK Equity Index performed well in Trustnet research earlier this year into both tracker cost and tracking error. [More details].

Cost factor: Consider how closely a tracker matches its index as well as assessing its fees before you invest

What are the benefits of a tracker?

The major appeal of trackers is that charges are low, due to the fact they do not need a team of expensive 'experts' behind them, unlike a traditional fund.

Most tracker funds have no upfront charges and only cost between 0.25 per cent and 1 per cent a year to run a year. A traditional unit trust or Oeic might charge you 5 per cent upfront and then 1.5 per cent of the fund’s value each year.

This means that a traditional fund would need to grow by 5 per cent in the first year to put you back where you started – although you can avoid this initial fee by using a fund supermarket. [More details here and here].

Traditional fund managers buy shares in companies that they hope will beat the relevant index, such as the FTSE 100 or the All-Share. Their aim is to achieve better returns than the wider stock market and you pay for their expertise.

However, in trying to beat the index, many pick the wrong stocks and the fund underperforms, spelling bad news for your investment.

Trackers are very different as they attempt to track the performance of the index itself, rather than beat it. This is because they believe that in the end, no traditional manager manages to do better than the index for very long. When markets rise, trackers ride high among the best performing funds. For example, the Fidelity MoneyBuilder UK went up 29.15 per cent during the rally of 2009 and 14.54 per cent in 2010.

And what are the downsides?

When a bear market begins to bite, trackers quickly slip down the fund performance league tables.

The Fidelity MoneyBuilder UK fund mentioned above slipped -30.17 per cent in 2008 and -5.07 per cent in 2011.

But despite this, they still often do better than many of the large popular funds favoured by small investors. Some people also believe that tracking an index results in imbalance, which a traditional fund manager could be able to avoid.

A traditional fund manager, in theory, would be able to see problems for certain sectors coming, for example miners or banks. It might have been able to sell some of these shares and buy other ones instead. A tracking fund cannot do this - it must hold shares in the companies that make up the index.

How do low-cost investment trusts compare to trackers?

We already know that investment trusts have beaten funds hands down over the past decade. [More details]

Trustnet research also reveals that some 85 per cent of trusts in the IT UK Growth sector have outperformed the average FTSE All Share tracker over 10 years.

'While proponents of trackers point to the underperformance of the majority of actively managed funds, the superior returns of investment trusts bring this argument into question,' it says.

Some 35 per cent of IMA UK All Companies funds have beaten the FTSE All Share index over 10 years, says Trustnet. However, 68 per cent of trusts in the IT UK Growth and UK Income & Growth sectors have managed to achieve this.

Trustnet finds that just two of 13 UK Growth trusts with a long enough track record have lost out to the average FTSE All Share tracker over 10 years compared with 83 of 169 portfolios in the UK All Companies sector.

Investment trusts also keep their costs low. The Association of Investment Trusts has league tables showing the 'ongoing costs' - the yardstick it uses in preference to TER - of trusts in the UK Growth & Income and the UK Growth sectors. [More details here and here].